How the Threat of Monetary Inflation Keeps a Currency Strong

Drip after drip of deflation data… Today’s release on manufacturing activity by the Richmond Fed is pretty ghastly, as you would expect given that the effects of fiscal stimulus are now wearing off at an accelerating pace – before the happy handover to the private sector is safely consummated – and given that the structural East-West imbalances that lay behind the global crisis are getting worse again… This follows yesterday’s horrendous fall in the Texas business activity index from the Dallas Fed, which fell from -4 in June to -21 in July. “Thirty-one percent of firms reported a worsening of activity, up from 22 percent in June,” said the bank. Texas New Orders were -9.6 in July, -8.2 in June, and +15.8 in May. Capacity Utilization was -0.6 in July, +2.7 in June, and +18.7 in May. This of course is why Fed chair Ben Bernanke has been giving strong hints of QE2 (helicopters again) if necessary.

Here is where it gets so interesting we can barely sit still. Ben Bernanke is threatening to drop money from helicopters (quantitative easing). In a better world, a banker who threatened to inflate the currency would be punished immediately. People would take him at his word. They would dump his paper money immediately. The price of it would drop. He’d be forced to protect it.

But this time it really is different. As Ben Bernanke himself put it, even the “credible threat” of monetary inflation by the central bank should be enough to cause people to want to spend paper money rather than save it. Thus, Bernanke promised, he can always speed up the velocity of money and thereby bring about a boom, of sorts, simply by threatening to drop money from helicopters.

But lately he threatens. And still the dollar holds firm. Why? Because the threat is not credible.

Oh what a wicked twist of fate. What has this world come to when a central banker cannot roll the currency markets and whack speculators?

Usually, central bankers are careful to give the impression that they will protect their currencies. Even while they are actually undermining them with monetary inflation. Investors catch on after they’ve been shellacked a couple times. Then, the central banker loses credibility and the currency falls.

But this time, Ben Bernanke actually wants investors to believe he WILL undermine the dollar. He wants to stimulate spending and investing by encouraging people to get rid of greenbacks rather than save them. But people don’t believe him.

Inflation is only really a threat, we conclude, when central bankers are pretending to prevent it…not when they’re trying to cause it.

But why won’t Ben Bernanke drop money from helicopters? Because he’s got a rope around his neck…and it’s getting tighter. As long the US can finance its deficits at low interest rates, he can’t move. It’s uncomfortable, but it’s a damned sight better than hanging. More on this as we figure it out.

Since founding Agora Inc. in 1979, Bill Bonner has found success in numerous industries. His unique writing style, philanthropic undertakings and preservationist activities have been recognized by some of America's most respected authorities. With his friend and colleague Addison Wiggin, he co-founded The Daily Reckoning in 1999, and together they co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster. His most recent project is The Bill Bonner Letter.

Ben’s position to stop inflation is severely weaker than a few years ago, with lower quality assets, longer maturities, to sell rather than simply not renew, if he wanted to shrink the money. That this is not a red flag to the markets means it’s overshadowed by the deleveraging, asset deflation, and fears of general deflation. Accordingly, threats to inflate are seen as just that. If the market thought he could really cause inflation, it would have reacted some time ago, but it doesn’t. At some point this will infuriate him sufficiently that he will really open the spigots, and then watch out – he does not have the concentration of T-bills he used to have to fight inflation.

Day Devil

Well, it could be a blessing when we see a helicopter on top of us unloading its paper bomb, firing missiles with paper warhead – that purportedly aimed to send us to hell. Then, all of a sudden we will be in fiscal celebration.

Bloomer

We are through the rough patch. Baltic index bouncing back. How strong will this bounce be is what everyone is thinking. I think Ben has a hand on the throttle and will apply more fuel if we start to stall.

Pinkus

I don’t think we’re through the rough patch. I think things only look as good as they because the government went nuts throwing money at the economy.

This will result in massive debts though that must depress the economy. Taxes will have to be increased…

This is all bad juju.

I recommend continuing to store food etc and keep some cash out of the bank and all the rest of the sensible precautions one puts in place facing the destruction of his nations’ economy.

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